A Call for the Creation of Socially Responsible Real Estate Investment Products
By Gary Pivo, MRP, PhD
The purpose of this essay is to suggest that it’s time to introduce real estate investment funds that are managed according to principles of socially responsible investing. As explained below, there may well be an enormous untapped market for such funds, which is estimated here to be on the order of $6 to $15 billion.
The Case in Brief
Individual investors are increasingly being advised to include real estate in their portfolios. It can “enhance the portfolio’s returns while helping to diversify volatility and risk.” According to one study, an investor that put 10% of his/her money into publicly traded real estate investment trusts in 1992 would have had 7.5% more in his account by 2001, compared to those who stuck with just stocks, bonds and cash. A recent review of the literature concluded that “real estate has a definite role in the formation of efficient portfolios. There are many works suggesting optimal allocations to real estate of approximately 10% to 20%.”
But real estate isn’t a socially or environmentally neutral commodity. Depending on how a development is sited, designed, and subsequently managed, the end result can either improve or harm the social and environmental fabric of a community. For example, the UN reports that inefficiencies in urban energy use, largely attributable to the nature of urban development, are a primary cause of the rise in greenhouse gas concentrations globally. Therefore, millions of socially responsible investors, who make investment decisions based in part on their social and environmental consequences, should have an interest in real estate funds that can “do good while also doing well.” 
At the present time there are few if any real options, aside from direct investment, for individuals interested in socially responsible real estate (SRRE). Despite there being over 300 real estate investment trusts, I have yet to identify a single one that makes social responsibility or sustainability an explicit goal. In fact, REITs have a tendency to seek out investments in the 19 standard real estate products, as a means of reducing risk. This only replicates the “conventional development” that tends to produce urban sprawl, auto-dependence, urban decline and other problems. One option is community development investment funds. But they typically spread their assets among low income housing, micro-lending, small business, and community development and may only be open to institutional investors or highly capitalized individuals. While there is a variety of socially responsible mutual funds and a variety of conventional real estate funds, so far there don’t appear to be any funds that merge the two and offer investors a professionally managed socially responsible and progressive real estate portfolio.
Possible Types of Funds
SRRE funds could take at least four different forms. One option could be publicly traded real estate investment trusts whose stocks trade on the public securities markets. These funds would acquire and manage a portfolio of SRRE. Another option would be private funds that are not traded on the public securities markets, which would buy and sell properties that meet their SRRE criteria, and would be sold to investors by the fund sponsors or securities brokers. A third form would be so-called funds of funds, which acquire interests in multiple private funds. The minimum investments required to become a member would be smaller than is normally required by private funds and the fund managers would provide a service by selecting the private funds to be purchased. A fourth option would be real estate mutual funds, which would buy and sell publicly traded REIT or development company stocks that pass social and environmental screening.
A primer on socially responsible investing
According to the Social Investment Forum (SIF), “socially responsible investing is an investment process that considers the social and environmental consequences of investments, both positive and negative, within the context of rigorous financial analysis.” It considers the “triple bottom line” by which investments are evaluated in terms of their financial profitability, social equity, and ecological integrity.
According to SIF, socially responsible investment
typically entails 3 strategies that work together to promote sound business
practices and societal improvements: Screening is the practice of including, excluding, or evaluating
investments on the basis of social and/or environmental criteria. Shareholder Advocacy entails
becoming involved as owners of corporate
indicate that investors are finding socially screened funds more attractive
than other funds. According to SIF,
screened funds attract and retain investor assets longer than non-screened
funds and socially responsible funds saw net inflows of
$1.5 billion during 2002 compared to a $10.5 billion outflow for
The Potential Market for SRRE
As noted above, an optimal allocation to real estate has been found to be 10 to 20 percent of a portfolio. If 10 to 20% of the approximately $150 billion now in socially responsible mutual funds were allocated to SRRE funds, they would contain $15 to $30 billion. Alternatively, if 2% of the funds now in publicly traded real estate investment trusts were moved to SRRE funds, matching the ratio of socially screen mutual funds to all mutual funds, the total in SRRE funds would come to over $6 billion.
Selecting SRRE Investments
A SRRE fund would use positive and negative screens to help select its investments. Positive screens would be used to emphasize smart growth and sustainable development such as urban and suburban infill, mixed use projects, green architecture, affordable housing, transit-oriented development, historic preservation, conservation communities, new urbanism, and sustainable forestry. Negative screens would be used to avoid investments that harm neighborhoods, fill wetlands, displace residents, discourage walking, demolish historic structures or produce other adverse consequences.
Any one SRRE fund wouldn’t necessarily invest in all types of real estate. Research on real estate investment trusts, for example, recommends some type of focused strategy. Thus, a SRRE fund could choose to limit its investments to a single type of property, such as multi-family housing. But a family of funds or a variety of separate funds could cover all types of properties.
One of the questions raised by the notion of screening is whether there would be enough opportunities to choose from. For example, there are currently only 137 LEED Certified projects, under the green building program administered by the U.S. Green Building Council. However, there are many thousands of apartments and office buildings located within walking distance of public transit stations, which is known to increase transit use and reduce driving alone. Additional research is required to determine how coarse or fine to make the screens, but it should not be assumed that only the most progressive projects or funds would be suitable for inclusion in SREE portfolios. Indeed, most socially responsible mutual funds only screen to avoid tobacco and alcohol related companies and so SRRE funds would not have to be particularly restrictive to be in line with normal industry practice.
Managing Properties: “Doing good by Doing Well”
One of the basic strategies followed by real estate funds is known as the value-added strategy in which they use their property management skills to increase the value and returns of under-performing properties. This approach can apply to SRRE management by using improvements in energy efficiency or water conservation, for example, to conserve resources, reduce utility costs, and increase net operating incomes. Moreover, many prospective tenants may well place a premium on socially responsible buildings because of their prestige, capacity to improve employee productivity, multi-modal accessibility, and other possible benefits. This should translate into higher rents and potentially better returns for investors.
Little is known about the financial performance of socially responsible projects compared to others. However, there is evidence that suggests SRRE may be at least as profitable as conventional properties:
· According to the 2003 Real Estate Performance Report by the National Council of Real Estate Fiduciaries, the 240 central business district office properties in their data base produced an average annual total return of 10.2% over the past 5 years, compared to 7.7% for 915 suburban properties. Downtown office buildings could easily be classified as SRRE because they use less land, generate less driving alone, and provide better access to jobs for lower income households. In addition, the same report shows that high-rise apartments, which by virtue of their higher density help save land, materials and energy, outperformed garden-apartments over the same 5 year period.
· Up until 2003, The Woodlands was owned by Crescent Real Estate Equities Company, one of the largest REITs. The Woodlands emphasizes the preservation of the natural forest environment and was designed by Ian McHarg, author of Design with Nature and one of the foremost landscape architects of the 20th century. According to Crescent, the company recognized over $200 million in funds from operations (FFO) and received more than $310 million in gross cash distributions over the approximate six-year life of their investment, which translated into a pre-tax internal rate of return of 43%.
· An academic study assessed the impact of new urbanism on single family home prices. It found that consumers were willing to pay 12% more for homes built in the Kentlands, compared to similar homes in surrounding areas. This demonstrates a consumer preference for living in walkable communities.
· A recent book on infill housing, published by the Urban Land Institute, reached the following conclusion: “Though developers are quick to agree that it’s easier to build in greenfields and that infill housing typically costs more to develop…they also agree that when infill housing succeeds, the financial returns for lenders and equity investors are greater over time.”
Funding Smart Growth
Two recent papers discuss the challenge of finding equity capital to support progressive real estate development. One of the problems is that it’s perceived as being more risky. This leads to higher required rates of return and pressure to produce cash flow quickly. The papers report a need for more patient funding sources, such as foundations or pension funds that have lower requirements on returns for their investments. SRRE funds might also help address this problem because socially responsible investors derive utility from knowing that their investments are being managed in a socially responsible manner and are thus willing to accept lower short term gains.
With the current level of interest in socially responsible investing and rapid growth in real estate investment funds, it is remarkable that there is no such mechanism that offers investors the opportunity to own socially responsible real estate. As demonstrated above, an extrapolation of currently expressed preferences for socially responsible investment, when applied to the real estate industry, suggests a market that is on the order of 6 to 30 billion dollars per year. Urban development has serious implications for our social, environmental, and personal health. Mounting evidence suggests the need for a mechanism that at minimum enables, but ideally facilitates and rationalizes, increased capital targeted at socially responsible, progressive forms of development.
author is grateful for comments received on an earlier draft from Dr. Lawrence
Frank, Bombardier Chair at the University of
 Dr. Pivo
works at the
 AllegisOne Guide to Real Estate Investment Funds. B.J. Yankowitz, President, Blue Sphere Capital Management, LLC.
study has estimated that LOHAS (Lifestyles of Health and Sustainability)
consumers comprise 30% of the
 See Financing Progressive Development by Christopher Leinberger, Prepared for A Capital Xchange Journal, published by the Brookings Institution Center on Urban and Metropolitan Policy and the Harvard University Joint Center on Housing Studies, May 2001.
 This typology of real estate funds is drawn from the AllegisOne Guide to Real Estate Investing, op cite.
Investment Forum. 2003 Report on Socially Responsible Investing Trends in the
 Investment Company Institute, Mutual Fund Fact Book, 44th Edition, 2004.
 Social Investment Forum, op cite.
Estate Investment Trusts: Structure, Performance, and Investment
Opportunities. Su Han Chan, John
Erickson and Ko Wang,
 LEED stands for Leadership in Energy and Environmental Design. The LEED process is a national leader in certifying green buildings. For more information contact the U.S. Green Building Council at www.usgbc.org.
 See Relationships Between Land Use and Travel
Behavior in the
 See Social Investment Forum, op cite.
 See AllegisOne Guide to Real Estate Investment Funds, op cite.
 Valuing New Urbanism: the case of Kentlands. Charles C. Tu and Mark J. Eppli, Real Estate Economics, v27, n3, Fall, 1999.
Developing Successful Infill Housing.
Diane R. Suchman,
 See C. Leinberger, op cite. Also see Financing New Urbanism Projects: Obstacles and Solutions, Joseph E. Gyourko and Witold Rybczynski, Housing Policy Debate, v11, n3, 2000.
Investing in Socially Responsible Mutual Funds. Christopher C. Geczy, Robert F. Sambaugh and